LOS ANGELES — San Bernardino, Calif. enters the final stage of its Chapter 9 bankruptcy with a plan for its pension obligation bondholders to take it on the chin.
The city intends to stand by its proposed
"We don't think it's unreasonable under our financial circumstances," said Saenz, who was elected city attorney in 2013.
In 2012, when the city filed for bankruptcy, San Bernardino was cash broke and could not meet payroll, he said.
"We were ready to go over a cliff," Saenz said. "The situation was bleak and it is still very bleak."
Attorneys representing the pension bondholders and insurer Ambac argue the bondholders are owed far more than the city is offering.
Richard Larkin, a senior vice president and director of credit analysis for HJ Sims, said that in San Bernardino, as in Detroit before it, decisions to sacrifice investors in bankruptcy will impact the cities' ability to issue pension obligation bonds in the future, Larkin said.
Holders of Detroit's $1.5 billion of pension certificates of participation emerged with a 14% cash recovery as well as a package of vacant land, asset leases, and development deals, after the city tried to sue to completely invalidate the debt.
While there have been changes in the makeup of the municipal bond market in recent years, Larkin said, those changes don't have enough permanency to assure Detroit or San Bernardino that they will be able to borrow long-term, or borrow affordably, to repair infrastructure and fund economic development needed for those cities to thrive.
One of the tests U.S. Bankruptcy Judge Meredith Jury will have to determine before she approves the city's exit from bankruptcy whether it will be able to remain solvent.
Saenz doesn't believe San Bernardino's treatment of its pension bondholders will impact the city's ability to issue bonds in the future.
"We believe our ability to access the market will depend on the ability to repay at whatever time we are trying to access and based on our credit rating," Saenz said. "That is what determines the ability to pay it back."
He added that the city would have lesser ability to pay back new bonds if it were still paying $2 million a year on its existing pension obligation bond debt.
"If we are successful at eliminating this in bankruptcy, our ability to pay back new loans would probably be enhanced," Saenz said.
The 1% recovery "is not a pretty picture," said municipal finance analyst Natalie Cohen, managing director at Wells Fargo Securities, LLC.
The fact that pension obligation debt is getting very poor treatment in several municipal bankruptcies will impact that entire sector, Cohen said.
"It is going to make it a lot harder for future issues for that type of security," she said.
The Chapter 9 cases are creating a hierarchy of creditors that has not been favorable to municipal bond debt, she said.
"The way things are playing out in bankruptcy case is that the tax can't be used for anything else but general obligation bonds," Cohen said. "So, if a city is out of money in the general fund the pension obligation bond or certificate is going to suffer."
When pension obligation bonds were sold to investors, they were marketed as being as strong as pension payments, Cohen said.
"Right now there is no disclosure, so to speak, so the investor can tell if the lien is as hard and fast as the statutory lien (given to the California Public Employees' Retirement System)," she said.
"Clearly, in Stockton and in Detroit, both judges affirmed in federal bankruptcy it is possible to alter the contract for pension benefits," Cohen said. "But Chapter 9 requires the debtor to propose the plan. The judge doesn't have the power to say, "This really isn't fair, go back to the drawing board."
In the San Bernardino debt hierarchy, secured debt obligations backed by City Hall and a police station are going to be impaired, Saenz said, but only by stretching out the debt service obligation over a longer period of time. Those bondholders will be paid because those obligations are secured by collateral the city needs, he said.
"We need City Hall and the police station to continue to provide services," Saenz said.
"It is not 'Let's sock it to the pension obligation bonds,'" he said; the city simply can't afford to pay the pension obligation bondholders more and also provide even a basic level of city services.
The 1% recovery "is the result of the calculation regarding our ability - that is the amount left to pay unsecured creditors," Saenz said.
CalPERS technically is an unsecured creditor too, according to Karol Denniston, a partner with Squire Patton Boggs LLP.
"This is a Chapter 9, not a Chapter 11 - they do have to do a reality check that the city was in free fall when it filed bankruptcy, so it is to be expected that the plan would be a little rough around the edges," Denniston said.
In Stockton, Calif.'s bankruptcy, she said, the most severely impaired bondholder, Franklin Templeton, argued that it was unfair that the city didn't cut its pension payments.
Franklin held paper backed by property not essential to the city government.
But employee pensions have to be looked at in the context of other retiree benefits, she said. Stockton cut employee retiree medical benefits and San Bernardino plans to cut them.
"The city also is giving the medical retirement benefits a huge haircut," Saenz said.
He also said that all of the city employees have been impaired in salaries and through increasing in the amount they contribute to their pensions.
Denniston anticipates that the POB attorneys will lodge the same argument that Franklin did - a good faith argument that the pension bonds are not being treated equally to CalPERS, with the added fact that the proceeds of the San Bernardino POBs went to pay CalPERS.
Those "good faith" arguments are, according to Denniston: was the filing of the plan was done in good faith; does the classification scheme meet the requirements of the bankruptcy code in terms of the hierarchy of creditors; and is the treatment of POBs fair and equitable when compared to creditors who are similar situated.
"The test is similar treatment for similar creditors," Denniston said.
"Those were the three planks in Franklin's argument in Stockton - and those will be the issues in San Bernardino," she said.
"A different class can be treated differently when the city's fiscal situation argues," Saenz said. "Under the good faith argument, if we were treating other unsecured creditors 50% and offering bondholders 1% -- that would be unfair."
According to Saenz, the city's "good faith and bad faith can be measured against our ability to live after bankruptcy."
Among the other losers in the city's survival plan is its fire department.
The city anticipates responses from 13 different service providers, including private and public contractors, to provide fire services because the city has been unable to reach an agreement with firefighters that the city could afford. It has yet to reach an agreement with police officers, but Saenz anticipates being able to reach an agreement.
The city will formally submit its plan of adjustment to the judge on May 30. A status hearing is being held in mid-June to discuss the plan.
